There are two ways you can pay down your debt — either apply your tax refund towards the debt with the highest interest rate or apply your tax refund towards the debt with the smallest balance.

Paying off your highest-interest-rate debt will save you the most money, but paying off the smallest balance might provide the psychological sense of victory that keeps you motivated to continue paying down your debts. Read more about these two popular debt payoff methods.

You can invest the entire tax refund as a lump-sum in a 529 College Savings Plan that you’ve set up for yourself, your child or a family member. You can also stick the refund into special savings account that you’ve designated for expenses you’ll incur during your student years that may not be 529 Plan-eligible, like the cost of paying for car insurance.

This is probably the single most important thing you can do to maintain strong financial health and prevent yourself from sliding into debt. Your emergency fund should contain 3 to 6 months of living expenses and should be held in an easily-accessible liquid account, like a savings account or a money-market account.

Speaking of taxes, why not use your tax refund to reduce your future tax bill? You can contribute $17,000 of your paycheck per year to your 401k if you’re 49 or younger, and an additional $5,500 if you’re 50 or better. That contribution is tax-deductible.

Alternatively, you can contribute $5,000 to your Roth IRA if you’re 49 or younger, or $6,000 if you’re 50-plus. Not everyone is eligible to contribute to a Roth IRA, though. The eligibility waivers based on your income and your marital filing status.

In 2012, a married couple filing jointly can make a full contribution if their earned income is $173,000 or less. A single filer can make a full contribution if earned income is $110,000 or less. Beyond those income levels, the amount that you’re able to contribute gradually diminishes until you cross a threshold after which you can’t contribute to a Roth IRA at all.

The adage “it takes money to make money” is true. Blindly throwing money at a business is a bad plan, but strategically investing in a side business might earn you solid rewards down the road.

You can invest your tax refund in the supplies you’d need to start selling jewelry or re-upholstering furniture. You can register a website and start selling products online. You can buy a lawnmower or a leaf-blower and start a weekend business doing neighborhood yard maintenance. You can save for a down payment on a rental property.

The Bottom Line

Don’t run to the nearest shopping mall with your tax refund — save it and invest it! You worked hard for that tax refund. Now it’s time to make your refund work for you!

By the way, there’s a strong argument against getting a tax refund, especially if you carry high-interest debt, such as credit card debt or a car loan. You should read why you should avoid a tax refund next year.